Contractual terms
Economic substance governs a transaction. Economic substance determines the result of such a transaction. Contractual terms might provide for a purported allocation of risks, but, in the end, the economic substance should be determinative of the result.
Between the controlled and uncontrolled, are the contracts the same? If yes, it means the market price has been used in the price to the associate. If there is a material difference, there would be the need for adjustment to take account of the difference in the contractual terms under controlled and uncontrolled persons.
It is suggested that tax administration should include an analysis of contractual terms as part of the functional analysis. Contractual terms might not be in writing. In that event, the multinational enterprise or the tax administration must deduce the contractual relationships for the parties’ conduct and the economic principles that govern relationships between parties.

ICAG
Accra

12th December, 2020

COMMISSIONER-GENERAL
GHANA REVENUE AUTHORITY
ACCRA
SIR,
COMPARABILITY FACTORS

Introduction
The sale of two vehicles with the same model and brand at USD84,500 and USD 91,000 to two differently buyers by Success Vehicles Ltd raises tax issues especially transfer pricing on the surface. In order to draw meaningful conclusion for the Commissioner-General, the following factors shall be considered:

Contractual terms
The price will be the same if the contractual terms are the same. Different contractual terms will create different pricing

Nature of the vehicles
There is the need to look at the vehicles critically and determine if the price differential is as a result of the nature of each vehicle.

FAR analysis
The FAR analysis looks at the following:
Function
Asset
Risk

Function
The function performs in each of the vehicle is worth noting to determine if there is an abuse in the pricing.

Asset
The asset used will also determine. In this case, the place of manufacture is worth taking into account.

Risk
The risk assumed in the manufacture of the vehicle is very important and can explain the price differentials

Economic condition at the time of producing each vehicle
What was the state of the economy at the time they were manufactured? Inflation, Interest and foreign exchange situation if different can explain the price differentials

Market penetration

New products hitting the market for the first time unknown to the market must be priced below its counterparts in order to get known before the price starts to see an increase.

Conclusion
The analysis of the factors above will help in the determination of the rationale for the price differentials.

Yours faithfully,

Boys Abre3 (Final Level Student)                                                                                  (6 marks evenly spread using ticks)

i) The Comparable Uncontrolled Price (CUP) method
The CUP method compares the price for property, goods or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. An uncontrolled price is the price agreed between independent parties for the transfer of property, goods or services. If the transfer is in all material respects comparable to the transfer between related parties, the price becomes a comparable uncontrolled price.
There are two possible types of comparison which are:

• Internal comparable uncontrolled price where the price to the controlled transaction is compared to the price charged in a comparable transaction between one of the parties to the transaction and an independent person and;
• External comparable uncontrolled price where the price to the controlled transaction is compared to the price of a comparable transaction between independent parties, both of whom are unrelated to the parties to the controlled transaction

The use of an internal comparable uncontrolled price is preferred because relatively the circumstances of the controlled transaction are likely to reflect more closely those of the uncontrolled transaction.                (2 marks)

ii) Resale Price (RP) method
The resale price method is based on the price at which a product that has been purchased from a related party is resold to an independent person. This resale price is reduced by the resale price margin representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit. What is left after subtracting the resale price margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. customs duties) as an arm’s length price of the previous transfer of property between the related parties.

The resale price method will be most useful where the reseller contributes little to the value of the product ultimately on-sold on an arm’s length basis. This is because reliable comparables are more likely to be found. The method will be most reliable if the reseller on-sells within a short time because the more time that lapses, the greater the risks assumed in relation to changes in the market, in rates of exchanges, etc. This, and similar issues, will become significant if there are significant variances between such business practices carried out by the tested party, and those carried out by parties identified as comparables. If there are significant differences that, at arm’s length, are likely to impact upon the return to resellers, it will be necessary to make comparability adjustments.             (2 marks)

iii) Cost Plus (CP) method
The CP method uses the costs incurred by the supplier of property, goods or services in a controlled transaction. An appropriate CP mark-up is added to this cost, to make an appropriate profit in the light of the functions performed taking into account assets used, risks assumed and the market conditions. What is arrived at after adding the cost plus mark-up to the above costs may be regarded as an arm’s length price of the controlled transaction.

The CP method starts by computing the cost of providing the goods or services and adds an appropriate mark-up. In contrast, the Resale Price method starts from the final selling price and subtracts an appropriate gross margin to arrive at a purchase price. The CP method will use margins computed after direct and indirect costs of production, while a net margin method will use margins computed after operating expenses of the person as well.          (2 marks)

iv) Transactional Profit Split (PS) method
The (PS) method identifies the aggregate profit to be split for the related parties from a controlled transaction(s) and then splits those profits between the related parties based on an economically valid basis. The combined profits to be split are the profits combined earned by the associated enterprises from the controlled transaction under review.

The profit may be the aggregate profit from the transactions or a residual profit intended to represent the profit that cannot readily be assigned to one of the persons. Factors to be taken into account in undertaking a profit split are:

• Whether the profit split is to be undertaken on a particular product line, an aggregation of products, or a whole of entity basis.
• Whether it is necessary to identify the persons in relation to the transaction and the profits of each person so as to determine the profits to be split among them if the person transacted with more than one connected person.
• Whether the accounts of the related persons need to be put on a common basis as to accounting practice and currency and then consolidated in order for the combined profit to be determined.           (2 marks)

v) Transactional Net Margin Method (TNMM)
The TNMM examines the net profit margin relative to an appropriate base such as sales, costs or assets that a person realizes from a controlled transaction or transactions that it is appropriate to aggregate. This is compared with the result achieved by independent persons on a similar transaction(s). The main difference between the transactional net margin method and the profit split method is that the former is a one-sided method” that is applied only to one of the connected persons, whereas the latter is applied to all the relevant connected persons.

The transactional net margin method requires the comparison of net margins obtained in its related party dealings against either:

• The net margins of the person’s dealings with independent persons in comparable circumstances; or
• The net margins earned in comparable dealings between two independent persons.               (2 marks)

The most suitable method for the transaction will be the Transaction Net Margin Method (TNMM).       (2 marks)

Justification:

• The transactional net margin method examines the net profit margin relative to an appropriate base such as sales, costs or assets that a person realizes from a controlled transaction or transactions that it is appropriate to aggregate. This is compared with the result achieved by independent persons on a similar transaction(s). The main difference between the transactional net margin method and the profit split method is that the former is a one-sided method” that is applied only to one of the connected persons, whereas the latter is applied to all the relevant connected persons.
• The transactional net margin method requires the comparison of net margins obtained in its related party dealings against either:
  The net margins of the person’s dealings with independent persons in comparable circumstances; or
  The net margins earned in comparable dealings between two independent persons.
• A search will be performed to identify a set of independent companies that could be used to determine an appropriate arm’s length range of return on marketing support services. The independent companies should be in the same industry/similar industry and in similar markets as the tested party, and services rendered should be similar.
• The search process will involve the examination of the companies in the database, the elimination of non-comparable companies, and the selection of those companies that are believed to be suitable as a benchmark for marketing support services. As a result of the search, a set of independent companies will be identified as comparable, which may be used as benchmark for the return that Pyrotechnics Ghana Limited should earn from the marketing support services.
  (4 points @ 1.5 marks each = 6 marks)

• To ensure that Ghana is able to tax on appropriate taxable basis corresponding to the economic activities deployed by taxable persons in Ghana, included in their transactions and dealings with associated enterprises.
• To provide the Ghanaian authorities the tools to fight tax evasion through over or under-pricing of controlled transactions between associated enterprises.
• To reduce the risk of economic double taxation.
• To provide a level playing field between multinational enterprises and independent enterprises doing business within Ghana; and
• To provide taxable persons with certainty of transfer pricing treatment in Ghana.              (Any 4 points)
  

Arm’s length principle is the principle that the conditions of a controlled transaction should not differ from the conditions that would have applied between independent persons in comparable transactions carried out under comparable circumstances.